[Federal Register Volume 64, Number 234 (Tuesday, December 7, 1999)]
[Notices]
[Pages 68404-68407]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-31640]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42191; File No. SR-NASD-99-02]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change by the National Association 
of Securities Dealers, Inc. Relating to the Application of Certain NASD 
Rules to Limited Offerings Under SEC Rule 504, Securities Exempted 
Under the Securities Exchange Act of 1934, and Intra-State-Only 
Offerings

December 1, 1999.

I. Introduction

    On January 13, 1999, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary NASD Regulation, Inc. (``NASD Regulation''), filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
amend certain NASD rules to clarify how they apply to offerings of 
securities made in reliance on the limited offering exemption from 
registration set forth in Rule 504 of Regulation D,\3\ and to make 
other changes. NASD Regulation amended the proposed rule change on May 
24, 1999.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 230.504.
    \4\ See Letter from Suzanne Rothwell, Chief Counsel, Corporate 
Financing Department, NASD Regulation, to Joshua Kans, Attorney, 
Division of Market Regulation (``Division''), Commission, dated May 
21, 1999 (``Amendment No. 1''). Amendment No. 1 modified the 
proposed rule change in response to the Commission's amendment of 
Securities Act Rule 504. See Securities Act Release No. 7644 
(February 25, 1999), 64 FR 11090 (March 8, 1999) (adopting amendment 
to Rule 504 under Regulation D, 17 CFR 230.504).
    NASD staff and Commission staff clarified the purpose of this 
proposed rule change, the scope of the rule impacted by this 
proposed rule change, and the NASD's response to an amendment to 
Rule 504 of Regulation D during telephone conversations between 
Suzanne Rothwell, NASD Regulation, and Joshua Kans, Commission, on 
February 1, February 8, May 12, and June 10 and July 30, 1999.
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    The Commission published notice of the proposed rule change in the 
Federal Register on June 18, 1999.\5\ The Commission received no 
comments. NASD Regulation filed a second amendment on November 1, 
1999.\6\ For the reasons discussed below, the Commission is approving 
the proposed rule change as amended.
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    \5\ Securities Exchange Act Release No. 41519 (June 11, 1999), 
64 FR 32907 (June 18, 1999).
    \6\ See letter from Suzanne Rothwell, Chief Counsel, Corporate 
Financing Department, NASD Regulation, to Nancy Sanow, Senior 
Special Counsel, Division of Market Regulation (``Division''), 
Commission, dated October 22, 1999 (``Amendment No. 2''). Amendment 
No. 2 corrected a typographical error which cited a word in NASD 
Rule IM-2110-1(l)(1) as ``to,'' rather than ``into.'' The amendment 
did not affect the substance of the proposed rule change.
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II. Description of the Proposal

    NASD Regulation proposes to change NASD rules in three principal 
ways. Most significantly, NASD Regulations proposes to modify several 
NASD rules to clarify when they apply to offerings of securities made 
in reliance on the exemption from registration for limited offerings 
that is set forth in Rule 504 of Regulation D.
    NASD Regulation also proposes to modify the Corporate Financing 
Rule, Rule 2710, to clarify that it applies to all offerings subject to 
the intra-state exemption set forth in Section 3(a)(11) of the 
Securities Act of 1933 (``Securities Act'').\7\
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    \7\ U.S.C. 77c(a)(11).
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    NASD Regulation proposes to modify the Conflicts of Interest Rule, 
Rule 2720, to clarify that it does not apply to securities exempted 
under Section 3(a)(12) of the Act.\8\
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    \8\ 15 U.S.C. 78c(a)(12).
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    Beyond those changes, NASD Regulation also proposes to modify these 
rules to make them consistent in form and easier to read.

A. Application of Rule 504 Offerings to NASD Rules

    Earlier this year, the Commission modified Rule 504 of Regulation 
D, which exempts certain limited-size offerings of securities from 
Securities Act registration requirements.\9\ As amended, all Rule 504 
offerings are subject to Rule 502(c) limitations on the manner of 
offering \10\ and to Rule 502(d) limitations on resale,\11\ unless the 
Rule 504 offering satisfies certain state law registration requirements 
or state law exemptions.\12\ Rule 504 contained

[[Page 68405]]

similar limitations prior to a July 1992 amendment that ended 
limitations on offering or on resale for Rule 504 offerings.
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    \9\ See Securities Act Release No. 7644 (February 25, 1999), 64 
FR 11090 (March 8, 1999).
    \10\ 17 CFR 230.502(c). Rule 502(c) prevents Regulation D 
offerings from being offered by any form of general solicitation or 
general advertising.
    \11\ 17 CFR 230.502(d). Rule 502(d) prevents securities acquired 
in Regulation D offerings from being resold without being registered 
under the Securities Act or being exempted from registration.
    \12\ A Rule 504 offering is not subject to Rule 502(c) 
limitations on the manner of offering or Rule 502(d) limitations on 
resale only when the offering is made: (i) exclusively in one or 
more states that provide for the registration of the securities, and 
require the public filing and delivery to investors of a substantive 
dislocure document before sale, and are made in accordance with 
those state provisions; (ii) in one or more states that have no 
provision for the registration of the securities or the public 
filing or delivery of a disclosure document before sale, if the 
securities have been registered in at least one state that provides 
for such registration, public filing and delivery before sale, 
offers and sales are made in that state in accordance with such 
provisions, and the disclosure document is delivered before sale to 
all purchasers (including those in the states that have no such 
procedure); or (iii) exclusively according to state law exemptions 
from registration that permit general solicitation and general 
advertising so long as sales are made only to ``accredited 
investors'' as defined in Rule 501(a) (17 CFR 230.501(a)). See 17 
CFR 230.504(b)(1).
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    NASD Regulation proposes to modify the text of three rules to 
clarify the way that those rules apply to Rule 504 offerings. The rule 
changes will also affect the scope and interpretation of several other 
rules.
1. Scope of Changes
(a) Free-Riding and Withholding Interpretation
The Free-Riding and Withholding Interpretation, Rule IM-2110-1, 
requires NASD members and associated persons to make a bona fide public 
distribution, at the public offering price, of any securities of a 
public offering which trade at a premium in the secondary market when 
the secondary market begins. The rule applies only to offerings that it 
defines as a ``public offering.'' This definition currently excludes 
Rule 504 offerings ``unless considered a public offering in the states 
where offered.'' \13\
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    \13\ NASD Rule IM-2110-1(l)(1). NASD Regulation states that the 
definition of the term ``public offering'' included in the Free-
riding and withholding Interpretation, Rule IM-2110-1, is limited to 
the application of that Interpretation. See Endnote 1 in NASD Notice 
to Members 98-48 (July 1998).
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    NASD Regulation proposes to amend the ``public offering'' 
definition to encompass all Rule 504 offerings--except for Rule 504 
offerings where ``the securities are `restricted securities' under SEC 
Rule 144(a)(3).'' Under Rule 144(a)(3), the term ``restricted 
securities'' includes securities that are acquired subject to Rule 
502(d) resale restrictions.
(b) Conflicts of Interest Rule
    The Conflicts of Interest Rule, Rule 2720, governs the ability of 
NASD members and associated persons to participate in distributing a 
public offering of the securities of an NASD member, or to participate 
in distributing a public offering of the securities of a company with 
which the member and/or its associated persons, parent or affiliates 
has a conflict of interest. Like the Free-Riding and Withholding 
Interpretation, IM-2110-1, this rule's definition of ``public 
offering'' currently excludes Rule 504 offerings ``unless considered a 
public offering in the states where offered.'' \14\
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    \14\ NASD Rule 2720(b)(14).
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    As with the Free-Riding and Withholding Interpretation, NASD 
Regulation proposes to amend the ``public offering'' definition of the 
Conflicts of Interest Rule to encompass all Rule 504 offerings except 
for offerings where ``the securities are `restricted' under SEC Rule 
144(a)(3).''
    This proposed change would affect the scope of several other rules. 
As discussed below, these include the Corporate Financing Rule, Rule 
2710 (which incorporates the definitions of Rule 2720), and the Direct 
Participation Programs Rule, Rule 2810 (which has a scope based on the 
scope of Rule 2710). Also, the NASD Regulation states that it relies on 
the ``public offering'' definition in the Conflicts of Interest Rule to 
interpret the scope of other provisions of its rules that reference the 
term ``public offering'' or ``public offering price.'' \15\
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    \15\ See NASD Rules 0120(h) (general definition of ``fixed price 
offering''), 0120(p) (general definition of ``selling group''), 
0120(q) (general definition of ``selling synidicate''), 2750 
(transactions with related persons), 2830 (investment company 
securities), 3350 (short sale rule), 3370 (prompt receipt and 
delivery of securities) and 6410(e) (definition of ``initial public 
offering'' in NASD systems and programs rules). As a matter of 
policy, the NASD interprets those provisions in the context of Rule 
2720's definition of ``public offering.'' Those provisions do not 
specifically reference Rule 2720, however.
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(c) Corporate Financing Rule and Direct Participation Programs Rule
    The Corporate Financing Rule, Rule 2710, prevents NASD members and 
associated persons from participating in certain offerings of 
securities unless documents relating to the public offering are filed 
with the NASD for review, and the NASD provides an opinion that it has 
no objection to the proposed underwriting and other terms and 
arrangements. The Corporate Financing Rule also prevents NASD members 
and associated persons from participating in the public offering of 
subject securities if the underwriting or other terms or arrangements 
are unfair or unreasonable.
    The Corporate Financing Rule incorporates the definition of 
``public offering'' set forth in the Conflicts of Interest Rule, rule 
2720.\16\ Accordingly, NASD Regulation's proposal to modify the 
Conflicts of Interest Rule's ``public offering'' definition--to apply 
to all Rule 504 offerings except for those that are restrict offerings 
under Rule 144(a)(3)--will similarly affect the scope of the Corporate 
Financing Rule. Moreover, the Corporate Financing Rule also applies to 
offerings governed by the Conflicts of Interest Rule, and to offerings 
governed by the Direct Participation Programs Rule, Rule 2810 
(discussed below).\17\
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    \16\ See Rule 2710(a). Also, Rule 2710(b)(7) exempts certain 
offerings from filing under the Corporate Financing Rule ``unless 
subject to the provisions of Rule 2720.''
    \17\ See Rule 2710(b)(1).
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    NASD Regulation also proposes to amend two other provisions of the 
Corporate Financing Rule. One of those provisions currently exempts 
Rule 504 offerings ``unless considered a public offering in the states 
where offered,'' \18\ and the other currently requires filing of 
offering documents for those Rule 504 offerings that are ``considered a 
public offering in the states where offered.'' \19\ NASD Regulation 
proposes to make those provisions parallel to Conflicts of Interest 
Rule's modified definition of ``public offering'' by replacing the 
language ``considered a public offering in the states where offered'' 
with a reference to Rule 144(a)(3).
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    \18\ Rule 2710(b)(8)(A).
    \19\ Rule 2710(b)(9)(D).
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    NASD Regulation states that the Corporate Financing Rule also 
influences the scope of the Direct Participation Programs Rule, Rule 
2810. The Direct Participation Programs Rule governs the ability of 
NASD members and associated persons to participate in the public 
offering of a direct participation program (a program which provides 
for flow-through tax consequences, such as a partnership). Although the 
Direct Participation Programs Rule does not explicitly define ``public 
offering'' or adopt another rule's definition of that term, NASD 
Regulation notes that the Corporate Financing Rule's filing 
requirements also applies to the Direct Participation Programs rule, 
and that the Corporate Financing Rule would govern those offerings even 
if the Direct Participation Programs Rule does not exist.\20\ 
Accordingly, the proposed amendments to the Corporate Financing Rule 
and the Conflicts of Interest Rule will affect the scope of the Direct 
Participation Programs Rule.
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    \20\ Conversations between Suzanne Rothwell, NASD Regulation, 
and Joshua Kans, Commission, February 1 and July 30, 1999.
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2. Intent
    The purpose of the proposed rule changes discussed above is to 
clarify that the Free-Riding and Withholding Interpretation, Conflicts 
of Interest Rule, Corporate Financing Rule and Direct

[[Page 68406]]

Participation Programs Rule apply to those Rule 504 offerings that lack 
limitations in the manner of offering or resale. NASD Regulation says 
that this is consistent with the treatment of other types of ``exempt'' 
offerings, such as Regulation A offerings (which lack limitations on 
the manner of offering or limitations on resale, and are subject to IM-
2110-1 and Rules 2710, 2720 and 2810). NASD Regulation states that it 
believes that it is appropriate to treat as ``public offerings'' all 
Rule 504 offerings that are not subject to limitations on the manner of 
offering or limitations on resale because those offerings share the 
characteristics of other public offerings.
    NASD proposes to effect this change by stating that those rules 
encompass all Rule 504 offerings except for offerings of securities 
that are considered to be ``restricted securities'' under Rule 
144(a)(3). Because the proposed formulation would exempt Rule 504 
offerings from those rules only if the securities are subject to Rule 
502(d) resale limitations, those rules effectively would reach all Rule 
504 offerings that lack limitations on the manner of offering or 
limitations on resale.
    NASD Regulation has also stated that the existing language, which 
excepts Rule 504 offerings that are not ``considered a public offering 
in the states where offered,'' has caused confusion and has been 
misapplied. In 1998, prior to the Commission's most recent amendment of 
Rule 504, NASD Regulation filed a different proposal to modify these 
rules.\21\ In that filing, NASD Regulation noted that some members had 
failed to file Rule 504 offerings with the Corporate Financing 
Department of NASD Regulation for review pursuant to the Corporate 
Financing Rule, even though all Rule 504 offerings at the time were 
sold without restrictions. Those failures to file continued into this 
year. Even with the recent amendment to Rule 504, some unrestricted 
Rule 504 offerings have not been filed with NASD Regulation for 
review.\22\ This proposed amendment is intended to eliminate any 
confusion of that nature by clarifying that the Corporate Financing 
Rule and the other rules apply to all Rule 504 offerings that are not 
limited in the manner of offering and resale.
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    \21\ See File No. SR-NASD-98-12. NASD Regulation later withdrew 
that filing.
    \22\ Conversation between Suzanne Rothwell, NASD Regulation, and 
Joshua Kans, Commission, July 30, 1999.
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B. Intra-State Exemption

    Section 3(a)(11) of the Securities Act exempts wholly intra-state 
offerings of securities from registration. The corporate Financing 
Rule, Rule 2710, currently states that it is not necessary to file 
documents and information relating to public offerings of securities 
exempt under Section 3(a)(11) ``which is considered a public offering 
in the state where offered.'' \23\ NASD Regulation proposes to remove 
that language from the rule, to require that all Section 3(a)(11) 
securities offerings be filed with NASD Regulation's Corporate 
Financing Department for review. NASD Regulation states that this is 
consistent with the definitions of ``public offering'' in IM-2110-1 and 
Rule 2720, which encompass all intra-state offerings exempt from SEC 
registration.\24\
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    \23\ NASD Rule 2710(b)(9)(D).
    \24\ The definitions of ``public offering'' in IM-2110-1 and 
Rule 2720 include ``all securities distributions of any kind 
whatsoever'' and do not exclude any type of intra-state offering.
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C. Exempted Securities

    Section 3(a)(12) of the Act \25\ defines ``exempted securities'' to 
include government securities, municipal securities, and several other 
categories of securities. NASD Regulation proposes to amend the 
definition of ``public offering'' in the Conflicts of Interest Rule, 
rule 2720, to exclude securities that fall within Section 3(a)(12)'s 
definition of ``exempt securities.'' Offerings of those securities 
already are exempt from Rule 2720, as well as Rules 2710 and 2810, 
pursuant to the language of Rule 2710(b)(8)(B). As noted above, NASD 
Regulation states that it relies on the ``public offering'' definition 
in rule 2720 to interpret the scope of other provisions of its rules 
that reference the term ``public offering'' or ``public offering 
price.'' \26\
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    \25\ 15 U.S.C. 78c(a)(12).
    \26\ See note 15, supra, and accompanying text.
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III. Discussion

    The Commission finds that the proposed amendments are consistent 
with the requirements of Section 15A(b)(6) and 15A(b)(2)of the Act.\27\ 
Section 15A(b)(6) of the Act specifies, inter alia, that the rules of a 
registered securities association should promote just and equitable 
principles of trade and protect investors and the public interest.\28\ 
Section 15A(b)(2) specifies, inter alia, that a registered national 
securities association should enforce compliance with its rules by its 
members and associated persons.\29\
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    \27\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \28\ 15 U.S.C. 78o-3(b)(6).
    \29\ 15 U.S.C. 78o-(b)(2).
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A. Application of Free-Riding and Withholding Interpretation, Conflicts 
of Interest Rule, Corporate Financing Rule and Direct Participation 
Programs Rule to Rule 504 offerings

    Several of the proposed amendments would govern the way that the 
Free-Riding and Withholding Interpretation, conflicts of Interest Rule, 
Corporate Financing rule and Direct Participation programs Rule would 
apply to Rule 504 offerings. The proposed amendments would directly or 
indirectly apply those rules to all rule 504 offerings of securities 
except for those that are considered to be ``restricted securities'' 
under Rule 144(a)(3). This formulation effectively would apply those 
rules to Rule 504 offerings that lack limitations on offering and 
limitations on resale, but would not apply those rules to Rule 504 
offerings that are subject to those limitations.
    The Commission finds that these proposed changes will promote just 
and equitable principles of trade, protect investors and the public, 
and promote compliance with NASD rules.
    the proposal would treat Rule 504 offerings in a manner that is 
consistent with other offerings, and would ensure that Rule 504 
offerings that are public in nature are subject to the important review 
and safeguards that these NASD rules provide.
    Moreover, by clarifying the intended scope of the NASD rules, the 
proposed rule change should eliminate confusion and should promote 
compliance with their provisions. The existing terminology--which 
applies these rule to Rule 504 offerings unless they are ``considered a 
public offering in the states where offered''--turns upon whether or 
not an offering is public in nature. The language, however, is subject 
to differing interpretations and has led some members to fail to submit 
public Rule 504 offerings for review under the Corporate Financing 
Rule. Accordingly, it is important to clarify that the Corporate 
Financing Rule and the other rules apply to Rule 504 offerings that are 
not subject to limitations on manner of offering or on resale.

B. Application of Corporate Financing Rule to Intra-State Offerings

    Another portion of the proposed rule change would clarify that the 
Corporate Financing Rule applies to all intra-state offerings of 
securities under Section 3(a)(11) of the Securities Act, not merely 
intra-state offerings that are ``considered a public offering in the 
state where offered.'' The Commission finds that this change will 
promote just and

[[Page 68407]]

equitable principles of trade, protect investors and the public, and 
promote compliance with NASD rules. The change will eliminate language 
that is potentially ambiguous, and would make Rule 2710's treatment of 
intra-state offerings consistent with IM-2110-1 and Rule 2720.

C. Application of Conflicts of Interest Rate to Offerings of Exempted 
Securities

    Another portion of the proposed rule change would clarify that the 
Conflicts of Interest Rule does not apply to offerings of securities 
that are exempted under Section 3(a)(12) of the Act. The Commission 
finds that this clarification will promote just and equitable 
principles of trade by clarifying the existing scope of the rule. 
Offerings of those securities already are exempt from Rule 2720, as 
well as Rules 2710 and 2810, pursuant to the language of Rule 
2710(b)(8)(B).

D. Clarifying Changes

    Finally, the proposed amendment would make clarifying changes to 
the rules that are not substantive, but which are designed to make 
their provisions consistent and easier to read. The Commission finds 
that these proposed changes will promote just and equitable principles 
of trade and promote compliance with NASD rules by making the rules 
clearer.\30\
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    \30\ As discussed above, NASD relies on the definition of 
``public offering'' in the Conflicts of Interest Rule, Rule 2720, 
when interpreting several other rules that reference the terms 
``public offering'' or ``public offering price.'' See note 15, 
supra. Accordingly, changes in that definition may impact NASD's 
interpretation of those other rules. The Commission notes that as a 
self-regulatory organization, the NASD is responsible for 
interpreting its own rules.
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    The Commission finds good cause for approving Amendment No. 2 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. Amendment No. 2 corrects a typographical error 
that has no effect on the substance of the proposed rule change.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether it is 
consistent with the Act. Persons making written submissions should file 
six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-99-02 and should be 
submitted by December 28, 1999.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change SR-NASD-99-02, including Amendment No. 2, 
is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
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    \31\ See 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 99-31640 Filed 12-6-99 8:45 am]
BILLING CODE 8010-01-M